This blog is maintained by two authors from the Great American Midwest

Sunday, April 17, 2016

The Federal Takeover of State Debt is About to Begin...

Often people focus on the "loud" items and miss the subtle, important events that really change the world. On the positive side, the 401(k) plan has that obscure name because a financial expert basically "invented" it out of a line in the tax code which enabled tax-deferred savings. And Jack Bogle of Vanguard did the same thing with "passive" investing, which reduced fees and for practical terms has taken over the investing world (along with ETF's).

One very subtle item that is about to occur is the nationalization of state debt (and likely debts of individual cities) by the Federal government. At the highest level, states and cities have made promises (mainly pensions) to their employees that are un-payable without raising taxes to extortionate rates. Detroit cracked first but since it was a city and there was some state framework they were able to use bankruptcy, but many more are to follow, including Puerto Rico (right now) and soon thereafter likely the city of Chicago or its' teachers' pensions as well as the state of Illinois.

A very similar event occurred in Europe when the ECB basically put the debts of Greece and Portugal onto the backs of taxpayers in Germany and Holland. The ECB had a moment (several moments, actually) when they could have fundamentally changed how Greece ran their economy, shutting down statist laws and heavy governmental interference in the economy to open up competition and growth, but they blinked and instead just "wired them money in exchange for promises". The Greeks, of course, haven't kept their promises, and why should they, given that the ECB continually blinks when the showdown occurs.

The reason that these states and territories like Puerto Rico are in dire straits is because they

1. spend more money than they make every year
2. rely on borrowing to pay for operating expenses
3. have giant, unfunded liabilities on top of this that can never be repaid (pensions, medical bills, etc...)

This situation is enabled by a governing class that views funds as an opportunity to redistribute wealth to favored constituents and relies on "fairness" as a bedrock of their planning. The apex of this sort of planning can be seen in crony capitalist states like Brazil, where large enterprises like the National Oil Company (partially on the stock market, partially owned by the state) are used to fund politicians and social programs and are systematically diverted away from their core mission (to make money) until the enterprises are bled almost totally dry and then, ironically, the state has to bail out the very companies that were supposed to provide for the socialistic wealth in the first place.

The CORE issue is - if you give these sorts of entities money (bailout) without a "root and branch" cleaning of the issues - you will just get more of the same, indefinitely, as their individually painful debts become part of the larger national (or pan-European debt) which continues the little game of overspending and wasting money on favored political groups for a little longer (maybe a couple years, maybe longer).

The slippery slope - the trigger - is occurring right now in Puerto Rico. That entire economy is corrupt and ridden with subsidies from electricity to taxes to everything else. For Puerto Rico to thrive, it would need to break down barriers to private enterprise, reduce taxes, levies and bureaucracy, and find some way to bring logical industry into their jurisdiction. However, the more likely course is as follows:

1. point out the current individuals suffering from a lack of funding (the poor, kids in school, the elderly)
2. note that the debt which was once owned by individuals was bought up by hedge funds for a fraction of their original value - these funds are in a position to fight (legally and politically) for repayment and although they may be termed "vultures" or something else, they really are the last man standing for the individuals without the means to fight legally for their rights
3. use the political system to "promise" reforms that will never be carried out (because why would you if you can use funds to enable the current system to thrive)
4. talk about the retirees and "promises" made to them over the years that cannot be paid and how they can't go back to the work force and earn more money so that they have to be made whole
5. use political or class warfare to point out the groups that run Washington don't look like the groups that are broke and make it a fairness issue or tied to some century plus grievance

It is very likely that these tactics will "work" and that the debts of Puerto Rico will be backstopped by the US government. While this technically isn't a "bailout", it absolutely is, because Puerto Rico can't borrow one dollar on their own anymore (who would loan money from someone who says they won't pay you back) and we know that without major reform (which won't happen), Puerto Rico will just continue to bleed money indefinitely (and fall back on fairness and the above tactics to ensure that this keeps happening).

Then soon after this subtle bailout (and likely before Puerto Rico fails AGAIN, which will happen again as it will with Detroit), entities of Illinois or the state itself will drive straight through this loophole and Federalize their debt, too. The state and entities will make lavish promises about change that will be never occur because this is the lifeblood of the Democratic party (patronage workers and the public sector) and all of the clout / featherbedding / etc... will continue on indefinitely, without any of the sorts of laws that enable competition.

Watch the headlines... see this occur... it will be seismic in its long term nature, because it will fundamentally change the nature of the US government, since the debts of the states and cities will become everyones' debt and we don't have any "real" tools to govern their behavior or fix the long term promises that destroy competitiveness and economic growth.

This is the real story, it is happening under our noses, and instead we are following these idiotic presidential campaigns of pure vapor.